Q61.
Consider the following statements: 1. Tight monetary policy of US Federal Reserve could lead to capital flight. 2. Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs). 3. Devaluation of domestic currency decreases the currency risk associated with ECBs. Which of the statements given above are correct?
Answer
A
Explanation
Statement 1 is correct: Tight monetary policy (Fed rate hike) strengthens the US dollar, causing US-based FPIs/FIIs to pull money from emerging markets like India and invest in safe-haven US assets — leading to capital flight. Statement 2 is correct: Capital flight causes rupee depreciation, which increases debt-servicing costs (in local currencies) for firms with foreign currency ECBs. Statement 3 is incorrect: Devaluation of domestic currency INCREASES the currency risk associated with ECBs (not decreases), as the firm must pay back more rupees to meet the same dollar obligation.